Tranferring Reps- B/D’s Need to Examine Potential Liabilities

Investment News recently published an article on discussing the ongoing practice of registered reps moving between brokerage firms throughout the financial services industry.  Oftentimes, reps will move to a new firm because of a more favorable compensation structure, other times because of a difference of opinion with the firm’s management or a change in management.

Regardless of the reason, oftentimes the moving rep can bring a significant amount of baggage to their new organizations – namely potential customer complaints involving securities recommended to their clients prior to the move.  This can be especially true with the smaller, independent B/D firms who may not have a large enough compliance department to perform the necessary background checks prior to becoming affiliated with the firm. B/D firms need to be cognizant of certain issues before becoming affiliated with reps in order to make sure that the unknown, unwanted baggage does not also accompany them.

In terms of risk management control with respect to transferring reps, there are many things a B/D firm can and should do to ensure a smooth transfer without liability.  For example, if a B/D firm is seriously contemplating an affiliation with a rep leaving another firm, the acquiring B/D should be sure to perform all the necessary background checks before making an actual hire.  However, the firm should also inquire about the rep’s specific client base at the old firm, including clients that terminated their relationship with the rep during that period of time.  Likewise, the firm should be familiar with the types of securities sold by the rep at his or her prior firm, namely whether the rep was engaged in the sale of reg-D offerings.  In the event the rep was engaged in such business, then the firm should be sure to review each and every one of those clients’ files to make sure that they also would have recommended the securities to the client – in the event the new firm would not have recommended those securities, then the new firm should not affiliate with the rep, or at the very least not allow that client’s account to be transferred, in the event the securities go south and client decides to name everyone possible in a FINRA arbitration.  Unfortunately it has become more and more common for clients to not only name the selling firm in a FINRA arbitration, but all other firms with whom the rep was affiliated during the time period of the investment.

Not only should the firm inquire about the clients being transferred along with the rep, but the firm should also inquire about any and all clients of the rep that are NOT transferring their accounts to the new firm.  Specifically, the new firm should inquire about all clients not being transferred, the investments made by those clients, and why those clients are not transferring their accounts with the reps.  The new firm should also keep a list of those clients so that the new firm’s compliance department can run random tests during its audits to ensure that the rep is not still providing advice to the client after the transfer, at risk of subjecting the new firm to a selling away complaint.  Furthermore, the new firm may be able to acquire more information about the rep’s business and activities based upon his or her dealings with clients not transferring their accounts than inquiring about clients moving with the rep – perhaps the rep is not bringing certain clients with him or her because of prior poor investment recommendations.  Such inquires about non-transferring clients can help a firm assure that the rep is not simply moving to the new firm in order to reap the benefits of the new firm’s Errors & Omissions insurance for an anticipated customer complaint, which can be a very common practice by reps since the recent wave of TIC and REIT-related arbitrations.

It is important to note that there is nothing wrong with a registered representative deciding to move from one B/D to another.  In fact, often times it is in the best interest of the client for a rep to make such a move.  However, firms need to be proactive and gain a solid understanding of who they are acquiring and why the move is being made.  Otherwise, the firm could be acquiring a book of goods that was not desired or anticipated, which depending on the circumstances, could be significantly detrimental to the firm’s future.

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